Core Trading Mainline

In September, the Federal Reserve's unexpected rate cut boosted risk appetite. Despite the gradual withdrawal of economic resilience and rate cut expectations, overseas assets continued to exhibit pro-cyclical characteristics. Domestically, a series of proactive and loose policies were rolled out, leading to a rapid improvement in market expectations and propelling a significant rebound in A-shares.

In the United States, the market played out the expectations of the peak and retreat of interest rate cuts. On September 18th local time, the Fed cut rates by 50 basis points, exceeding the unanimous expectations of Wall Street institutions (25bps). The first substantial rate cut had a short-term stimulating effect on the stock market and metals such as gold and copper. Within a week after the rate cut, due to the September Markit manufacturing PMI preliminary value still falling short of expectations, market expectations continued to intensify, with the growth-oriented Nasdaq rising by 2.9% in the week following the rate cut. After the rate cut arrived as expected, the interest rate-sensitive real estate sector first released optimistic signals. On September 25th, the August new home sales exceeded expectations, prompting the rate cut expectations to peak and retreat. In the following week, both the August JOLTs job vacancies and the September non-farm employment exceeded expectations, with the unemployment rate falling back to 4.1%, further reducing rate cut expectations.

With the unexpected recovery of key economic data, the market continued to show pro-cyclical characteristics. As the economy began to stabilize, the valuation boost brought by the rate cut itself was relatively limited, while the economic recovery helped improve profits. Against this backdrop, the pro-cyclical sectors continued their expansion trend. Third-quarter data showed that capital expenditures in industries such as capital goods, consumer discretionary goods, and raw materials maintained year-on-year growth or continued rapid growth. Correspondingly, the capacity utilization rates in related industries were at high levels, and there were also signs of a bottoming recovery in capital expenditures in the real estate industry. Influenced by the recovery in the real estate and labor markets, the 10-year U.S. Treasury yield once again broke through 4%.

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At the start of this round of rate cuts, residents had more cash, lower debt, and a low real estate vacancy rate. The financial cycle was also in an upward phase, with strong underlying economic resilience, coupled with fiscal and monetary dual looseness, which may promote a faster recovery of the U.S. economy and strengthen the pro-cyclical logic of overseas markets. Specifically for October, we continue to be optimistic about pro-cyclical sectors such as real estate (chain), consumer discretionary, industry, raw materials, and energy outperforming. We judge that the U.S. Treasury curve will continue to steepen, with the 10-year rate fluctuating between 3.9% and 4.2%, accompanied by the dissipation of uncertainty, rising inflation, and demand, the long-end rate is expected to trend upwards. Among commodities, gold is expected to maintain strength; affected by geopolitical conflicts, oil price upward pressure has intensified; the resilience of the U.S. economy and global structural demand support copper prices to fluctuate at high levels, with hopes of once again surpassing $10,000 per ton. Of course, copper and oil are also more influenced by domestic (fiscal) policies at present.

Domestically, the current market trading mainline focuses on industries that have previously experienced significant declines and those directly benefiting from policies, with market styles quickly switching. In the first phase from September 24th to the end of September, influenced by the positive tone of financial policies and the Politburo meeting, A-shares saw a rapid general rise, with the market trading mainline focusing on the following three directions: 1) Industries that had previously experienced significant declines had greater rebound elasticity, such as the consumer goods and consumer services sectors, while sectors like energy, public utilities, and banks, which had relatively better performance earlier, saw lagging gains; 2) Industry sectors directly benefiting from policies led the gains, with sectors like non-bank finance, real estate, and construction materials seeing significant increases; 3) Growth styles led the gains, with sectors like computers, electronics, communications, and new energy, which have higher valuations, leading the gains in this phase. Subsequently, entering the second phase of the policy waiting period at the beginning of October, the market began to correct, with increased volatility, but still accumulating significant gains compared to before the policy was introduced on September 24th. During this period, the market style returned to stability, with banks and public utilities showing strong resilience, while cash cows, dividend-paying stocks, and central state-owned enterprises experienced smaller pullbacks; the回调 degree of industries such as real estate and construction materials, which benefited from policies, was also relatively small. Policy benefits significantly boosted market sentiment, but at the same time, influenced by the pace of policy introduction and geopolitical risks, market styles underwent rapid switching and rotation in the short term.

The current market repair is mainly driven by policy-driven market sentiment improvement and capital inflow. How fiscal policy will be exerted and the improvement of fundamentals are key to the sustainability of market rebounds. At present, monetary policy is exerting itself, combined with financial regulation and capital market reform measures, which have had a positive impact on stock market expectations. However, in the second half of the financial cycle, against the backdrop of prominent demand insufficiency, the importance and necessity of fiscal expansion to stimulate economic growth and alleviate financial risks are more significant. According to the historical experience of "policy bottom-market bottom-economic bottom" in A-shares, the current policy bottom signal is relatively clear, but it still needs to be consolidated, especially with further efforts from fiscal policy. The confirmation of the policy bottom helps further improve market expectations and the formation of future economic bottoms, transforming the short-term market sentiment and capital-driven market trends into medium to long-term fundamental-driven certain rebounds. In terms of style, we continue to be optimistic about cash cows and central state-owned enterprises with more stable free cash flows and higher dividend yields. At the same time, the "soft landing" or even "no landing" of the U.S. economy benefits targets with higher foreign demand exposure or faster growth rates, among which consumer discretionary, telecommunications services, and energy resources, and other cash cow industries have a higher proportion of overseas revenue (Chart 11). It is recommended to continue to focus on the spillover and pull of the U.S. pro-cyclical to A-shares, focusing on two main lines: 1) durable goods that reflect the resilience of household sector demand, such as hardware and plumbing, furniture and home, household equipment, etc.; 2) computer electronic equipment, industrial equipment, chemical products, coal and petroleum products, etc., that reflect equipment investment and manufacturing cycles.

October Theme: Sino-American Monetary and Fiscal Resonance and Loosening

With the Federal Reserve officially starting interest rate cuts in September, we believe that China and the United States have entered a new round of monetary and fiscal resonance and loose policy cycles. In the United States, we expect the interest rate cut cycle to continue into the first half of next year. The Fed is also expected to end quantitative tightening at the end of the year, keeping the scale of bank reserves in a moderately abundant state (about $3.2 trillion). At the same time, in the short term, the U.S. fiscal policy will significantly re-strengthen in the second half of this year; in the medium to long term, we believe that the two parties in the United States will most likely continue functional large-scale fiscal policies to reverse the most severe wealth gap in forty years and strive to revive its manufacturing industry.

Domestically, the current trend of economic repair and improvement remains unchanged, but domestic demand still needs to be stimulated by the coordination of monetary and fiscal policies. Since late September, multiple ministries and commissions have held press conferences one after another, introducing a package of incremental policies to stabilize expectations, promote growth, and boost confidence. On October 12th, the Ministry of Finance released a more proactive fiscal policy signal at the National Press Conference, pointing out that the central government still has a large debt space, and it will increase support for local debt resolution, as well as take multiple measures to alleviate fiscal revenue and expenditure pressure within the year, reflecting the dual increase in fiscal efforts to stabilize growth and prevent risks [3].Over the past two decades, China and the United States have experienced two periods of synchronized monetary and fiscal policy easing, namely from September 2008 to June 2009 and from November 2019 to December 2020.

From 2008 to 2009, the U.S. financial crisis erupted, and the domestic economy also shifted towards contraction. With the active cooperation of monetary and fiscal policies, the domestic risk preference was significantly repaired. In terms of the domestic economy, the actual GDP growth rate fell from 11.5% in Q1 2008 to 6.4% in Q1 2009 quarter by quarter. The export growth rate plummeted from 19% in October 2008 to -2.2% in November, resulting in a rare 13-month negative export growth. The CPI year-on-year fell rapidly from 8.7% in February 2008 to -1.7% in June 2009. For the first time since 2002, both CPI and PPI turned negative simultaneously. In terms of policy, the monetary policy in 2008 experienced a shift from tightening at the beginning of the year to easing in the second half of the year. In the first half of 2008, the central bank raised reserves five times, and in the second half, it lowered reserves four times and cut interest rates five times. At the same time, fiscal policy also shifted from prudent to active, launching the "four trillion" stimulus policy, expanding the fiscal deficit scale from 180 billion yuan in 2008 to 950 billion yuan in 2009, introducing policies such as "cars to the countryside" and "home appliances to the countryside" to promote consumption, and further expanding domestic demand and promoting economic growth with ten measures. In terms of the market, the large-scale economic stimulus policy led to a significant rebound in the domestic economy in 2009. The actual GDP growth rate returned to a double-digit level of 11.9% at the end of 2009, and the CPI, PPI, and export growth rates all turned positive. The cumulative year-on-year growth rate of fixed asset investment reached 30.4%, a new high since 1994, and the new RMB loans increased to 9.6 trillion yuan, a 96% increase from the previous year. With the rapid recovery of the domestic economy, driven by both profits and valuations, the A-share market rebounded significantly, with the Shanghai Composite Index rising by 71% from the bottom. The S&P 500, gold, and CRB commodity index all achieved a V-shaped reversal, rising by 25%, 28%, and 18% respectively from the bottom.

From 2019 to 2020, with the addition of the COVID-19 pandemic, the global economy was under pressure, and China and the United States launched a new round of monetary and fiscal dual easing, and the A-shares and U.S. stocks achieved a V-shaped reversal. In terms of the domestic economy, in 2019, against the backdrop of slowing down and shifting gears, the domestic economic growth rate further declined, with the actual GDP growth rate falling below 6% in 2019. The export growth rate fell from 10% in 2018 to 0.5%, and the year-on-year growth rate of industrial enterprise profits was -3.3%, falling into negative growth again after 2015. The PMI was below the boom-and-bust line for six consecutive months from April to October 2019. Coupled with the outbreak of the COVID-19 pandemic in 2020, the global economy fell into a recession, and the domestic GDP recorded a negative growth for the first time in Q1 2020. In terms of policy, to alleviate the downward pressure on the domestic economy, the central bank lowered the MLF rate by 5bp in November 2019 and lowered the MLF by a total of 30bp twice after the outbreak of the COVID-19 pandemic in 2020. Fiscal policy continued the active tone since 2008, and the overall tone of fiscal policy in 2020 shifted from "strengthening and improving efficiency" in 2019 to "more active and effective," issuing 1 trillion yuan of special bonds for epidemic prevention and further reducing fees and taxes, and lowering the VAT rate for industries such as manufacturing. In terms of the market, under strong epidemic control and economic stimulus measures, the domestic economy rebounded rapidly. By the end of 2020, various economic indicators had recovered or even exceeded pre-epidemic levels. The Q4 actual GDP growth rate rose to 6.4%, and the PMI rose to around 52, a new high since 2018. The domestic economy took the lead in recovering overseas, driving the export growth rate back to 20%. The domestic epidemic was well controlled, and the rapid economic recovery drove a significant rebound in A-shares, with the Shanghai Composite Index rising by 26% from the bottom. The S&P 500, gold, and CRB commodity index all achieved a V-shaped reversal, rising by 45%, 30%, and 43% respectively from the bottom.

Core Quantitative Model

Macro Trading Factors

Using the prices of major asset classes to construct factor simulation portfolios can reflect the market's implicit expectations for economic growth (PMI), inflation (PPI), and liquidity (M2-social financing). Specifically, in terms of growth, the growth expectations reflected by the comprehensive prices of major asset classes in September compared to August have marginally improved, expecting the PMI year-on-year (12M MA) to return to above the boom-and-bust line in the next 12 months, among which the significant rebound of the CSI 300 in September contributed more to the improvement of growth expectations; in terms of inflation, the PPI year-on-year in August further weakened compared to July, leading to an overall downward adjustment of the market's inflation expectations, showing a overall trend of fluctuating and weakening, but marginally improved, among which the rebound of the可选消费板块 and copper prices contributed more to the improvement of inflation; in terms of liquidity, the expectation in September is that liquidity will further tighten compared to August in the next 12 months, fluctuating around -1%, among which the overall poor performance of small-cap stocks contributed more to the expectation of tightening liquidity. From the perspective of macro trading main lines, the asset prices reflecting the liquidity factor are expected to fluctuate more, becoming the main macro factor affecting recent market trading.

Valuation and Capital Allocation

In terms of market valuation, in traditional valuation, as of the end of September, the PE valuation of the CSI 300 is 13.3 times, located at the 69% percentile of the past 10 years, slightly lower than one standard deviation above; the ERP of the CSI 300 is 5.4%, located at the 63% percentile of the past 10 years, still slightly higher than the 10-year historical average level; the PE valuation of the S&P 500 is 27.3 times, located at the 93% percentile of the past 10 years, higher than one standard deviation above; the ERP of the S&P 500 is -0.15%, located at the 5% percentile of the past 10 years, lower than one standard deviation below. In addition, according to the proportion of stocks in financial assets (including equity, bonds, cash) as the asset allocation valuation model of stock valuation (Aggregate Investor Allocation to Equities, AIAE), it has a good leading effect on future stock returns. As of the end of September, the proportion of domestic stocks in financial assets is about 18%, at the lowest level since 2016. Under the mean reversion trend, in the long run, as the stock allocation ratio is repaired upwards, the future return rate of A-shares is expected to trend upwards; as of the second quarter, the proportion of U.S. stocks in financial assets is about 50%, at the 90% percentile level since the 1990s, implying that in the long run, there is a risk of a downward trend in the future return rate of U.S. stocks.

In terms of capital allocation, the current proportion of foreign capital allocated to A-shares in global stocks is about 3.6%, at the 19% percentile level since 2015; from the perspective of the proportion of active funds compared to passive funds, foreign capital is still under-allocated to A-shares; in September, foreign capital flowed into A-shares overall, mainly passive funds, and active funds turned from net outflow to net inflow for two consecutive weeks at the end of September and the beginning of October. The current proportion of foreign capital allocated to U.S. stocks in global stocks is about 65%, at the 99% percentile level since 2015; from the perspective of the proportion of active funds compared to passive funds, foreign capital is still over-allocated to U.S. stocks; in September, foreign capital flowed into U.S. stocks overall, mainly passive funds, and active and passive funds turned from net inflow to net outflow in the last week of September, but then turned back to net inflow in the first week of October.

Based on the above valuation and capital allocation indicators, A-shares are currently at a relatively low level in terms of valuation and capital allocation over the past decade, with high allocation value; the valuation and capital allocation levels of the U.S. stock market are at relatively high levels. In other countries, the valuation and capital allocation levels of the Indian and Japanese stock markets are also at relatively high levels; the valuation and capital allocation levels of the German stock market are relatively reasonable.Stock and Bond Scorecard

The latest scorecard for October shows that the market sentiment boost brought about by the introduction of proactive policies, marginal improvement in growth, and the decline in domestic and international interest rates due to central bank reserve ratio cuts and interest rate cuts by the People's Bank of China and the Federal Reserve, all contribute to a favorable impact on A-share returns. Inflation, on the other hand, exerts a certain drag on A-shares. In the context of a rate-cutting cycle, macro factors are also generally favorable for bonds. Overall, the results of the macro factor model for October indicate a more favorable outlook for A-shares.